Said Jay, though we’re strongly committed To make sure no ‘flation’s permitted Quite frankly we’re lost And ‘fraid of the cost If we screw up cause we’re dim-witted So, we’ll watch the data releases And act if inflation increases But if it should fall Then it will forestall More hiking lest we step in feces
As expected, the Powell comments were yesterday’s highlights as he once again explained that the goal of 2% inflation remains their primary effort. Not surprisingly, given what we have heard from the onslaught of Fed speakers over the past two weeks, he made clear that there will be no rate hike at the November meeting, but December is still in play. When asked about the rise in long-term yields, he did indicate it could be doing some of the Fed’s work for them, just like we heard earlier this week from Lorrie Logan and others. Somewhat surprisingly, he mentioned the rising budget deficits, describing them as on an “unsustainable” path. Now, we all know this is true, but Powell has been extremely careful not to discuss government funding throughout his tenure as Chair. I suspect his next testimony to Congress could be a little spicier!
Of course, the other six speakers added exactly nothing to the conversation as they merely reiterated in their own words the same message. Perhaps of more interest was that despite effective confirmation that there was no hike upcoming and that the bar for a December rate hike was quite high, bonds continued to sell off with the 10yr yield closing at 5.0% while stocks took it on the chin again. Methinks there is more than a little concern starting to grow amongst asset managers that the concept of the Fed put may finally be gone.
The other really interesting outcome yesterday was the fact that gold rallied another 1.3% despite the ongoing rise in interest rates. As there was no new news out of the Middle East of any real note, one possible explanation is that investors are simply getting quite scared overall.
One thing is quite certain and that is if the situation changes such that Powell and company become concerned that the economy is reversing course and they have, in fact, overtightened monetary policy, any reversal of the current message is likely to lead to some very big moves. In that case I would expect a much weaker dollar, a huge rally in gold and other commodities, an initial rally in equities and, remarkably, not much movement in bonds. I remain of the strong belief that the supply issue is the key bond market driver, so that will only increase in the event of an economic slowdown and that cannot help the bond market, even if the Fed starts to buy them again. But that is all hypothetical.
Turning to the overnight session, while risk continues to be shed in Asia and Europe, we did see Japanese inflation data where the headline rate declined to 3.0% and the core to 2.8% although their super core reading is still at 4.2%. Certainly, Ueda-san must be pleased that the numbers are beginning to edge a bit lower although they remain far above the 2% target. Of course, the very fact that they are edging lower implies that any end to QQE is even further in the future. Recall, Ueda-san has been clear that he does not believe 2% inflation is yet sustainable in the economy and is concerned it is going to slip back below that level in the medium term. With that attitude, he has exactly zero incentive to end YCC or QQE and seems far more likely to continue with them.
The implication of this outcome is that the yen seems likely to weaken further. Currently, USDJPY is trading at 149.95 and although it hasn’t touched the 150 level since that first brush on October 3rd, it has been grinding ever so slowly back there again. This price action has all the earmarks of stealth intervention, something that may be carried out by the three Japanese mega banks at the BOJ’s behest. However, given the ongoing trajectory in US interest rates, it seems only a matter of time before we once again breech 150. It will be quite interesting to see the MOF/BOJ reaction at that time, although I suspect they will, at the very least, “check rates.” For hedgers, be careful here.
And really, that’s all we’ve got to talk about today. As mentioned above, equity markets fell in Asia overnight, with losses on the order of -0.5% or so and European bourses are all down about -1.0% this morning heading into the US open. As to US futures, at this hour (7:00) they are off about -0.4% as we head into an option expiration session. Thus far, earnings season has not been sufficient to excite investors and fear seems to be the driver of note.
Turning to the bond market, while we have backed off from yesterday’s closing highs of 5.0% by 5bps, we remain at multi-year highs and there is no reason to believe that we have seen the top in yields. In fact, this move appears to be driven by rising real yields, not inflation concerns. While real yields have already risen substantially over the past 6 months, rising from ~1.0% to the current 2.45%, history has shown that real yields can easily rise to 4% or more in the right circumstances, and these may just be those circumstance. Again, there is no evidence that Treasury yields have topped. As to European sovereigns this morning, they are edging lower by about -1bp after a large rally yesterday as well. US Treasury price action continues to be the global driver for now.
Oil prices (+1.5%) continue to trade higher as concerns over a widening of the Israeli-Palestinian conflict keep traders on edge. Combine this with the weaker production numbers from the US and the drawdown in inventories and you have the ingredients for a further price rally. News that a US Missile Cruiser in the Red Sea shot down several drones and missiles launched from Yemen cannot have helped sentiment. Meanwhile, gold (+0.4%, +2.6% this week) continues to play the role of safe haven. Either that or there is a lot of short-covering ongoing. The price is approaching $2000/oz, one of those big round numbers on which markets tend to focus so I would look for a test there if nothing else. However, base metals are softer this morning as the price action today is not economically related.
Finally, the dollar continues to tread water this morning with most of the major currencies within +/- 0.2% of yesterday’s closing levels while EMG currencies seem to be edging a bit lower, down on the order of -0.3%. The renminbi is little changed this morning despite (because of?) the PBOC injecting CNY733 billions of fresh liquidity into the market/economy there overnight. Again, just like the yen, the diametrically opposed monetary policy of China and the US should lead to further currency weakness here over time. Now, the PBOC doesn’t like to see sharp movement and will continue to prevent a blowout move, but the spot rate is currently trading right at its 2% band vs. the CFETS fixing, so something has got to give soon. In the end, the dollar trend remains intact, but I must admit I am surprised it is not a bit stronger given the underlying fear in the market.
On the data front, there are no statistics released and we hear from two more Fed speakers, Harker and Mester, to finish things off before the quiet period begins. It seems hard to believe that anything they say will be seen as more important than Powell’s comments yesterday. As such, looking at today’s market activity, while there will be tape-watching regarding the Middle East and any escalation in hostilities, I suspect the equity market will have the most influence on things. At this point, further weakness seems the most likely outcome, especially as traders will be reluctant to be overly long risk heading into the weekend.
Good luck and good weekend
Adf
fxpoetry 